With more investors diversifying their investment portfolios,
cryptocurrencies and other kinds of digital assets (i.e.,
non-fungible tokens “NFTs”) have become a more popular
option in recent years. With the Internal Revenue Service declaring
that digital assets are property, they can be accessed by
creditors, however, so certain kinds of trusts may be established to help protect
these assets as well as enabling access to online accounts,
especially for cryptocurrency assets. A state-based Domestic Asset
Protection Trust (DAPT) enables a trust creator
(“trustor”) to protect their exiting digital assets
through a legal instrument that shields them from creditors.
Previously, these types of trusts were only available offshore. Fortunately, many
states across the U.S. have adopted DAPT statutes to allow this
type of trust to be legally-established within their
jurisdictions.
What is a Domestic Asset Protection Trust?
Before DAPTs were enacted, a trustor/settlor would have to
establish an irrevocable trust created by a third party in order
for asset protection. A DAPT is a self-settled trust that allows
the trustor/settlor protection to be the beneficiary, transfer a
portion of estate assets to the trust, and provide for certain
protections from future creditors, legal complaints, malpractice
claims, and other financially-consequential events. Formally known
as a qualified spendthrift trust, it is a trust that enables the
trustor to transfer assets into a trust of which the
trustor/settlor is also a beneficiary to protect themselves from
creditors. This type of irrevocable trust may assure that wealth
can be safeguarded for future generations and protects wealth from
liability risk.
Each state has slightly different statute of limitations and
creditor exemptions. So far, the states of Alaska, Connecticut,
Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New
Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee,
Utah, Virginia, West Virginia, and Wyoming have passed DAPT
legislation. Additionally, DAPT legislation usually abolishes the
Rule Against Perpetuities and allows for dynasty trusts.
Meanwhile, ten states that have not passed DAPTs, such as New
York, do offer similar provisions within an irrevocable grantor
trust.
With not every state enacting a DAPT statute, case law has primarily determined that
residents of states without DAPT laws who establish a DAPT in a
DAPT state will not likely have their trusts upheld in their home
states. The situs of the trust, which is typically determined at
inception, will likely determine whether or not DAPT law will
apply. Ultimately, while cryptocurrencies and other digital assets
on the blockchain are a global currency, the location of the trust situs will
determine whether a DAPT law applies. While the state-by-state
adoption of the DAPT legislation is not universal yet, at least a
trustor/settlor can establish a DAPT in the U.S. knowing that their
assets won’t have to be sent overseas in order to be
protected.
Trusts and Cryptocurrencies Tax Liabilities
A trustor/settlor could use a DAPT solely for their cryptocurrency and digital assets.
However, the cryptocurrency will still be subject to federal (and
state) taxation. Crypto transferred into a living trust is taxable
because the living trust is not considered a separate taxpayer.
With non-grantor trusts, the transferor is not taxed, but the trust
pays taxes and trust distributions may be taxed. With the
self-settled, irrevocable trusts, the trustor/settlor remains the
beneficiary so any taxable income or deduction earned by the trust
will be taxed on the trustor/settlor’s tax return. Even
offshore digital asset trusts will be subject to U.S. taxation. If
the trustor/settlor decides to open an offshore asset protection
trust …….